Many people say that equity crowdfunding and p2p lending are related cousins since both allow people to provide investment capital to other people. So it is interesting to see that while the US regulators have been creating regulation around equity crowdfunding as part of the JOBS Act, the UK regulators have been concurrently designing regulation around p2p lending.
Coincidently, the SEC voted yesterday to propose rules around equity crowdfunding while the UK’s equivalent body, the FCA, issued this consultation paper today to propose rules around p2p lending. If all goes according to plan, then US equity crowdfunding will be implemented in January 2014 and UK p2p lending regulation will be implemented in April 2014. In this post I provide a little history on the UK government’s involvement with p2p lending and I highlight some pointers on best practices and regulation that could eventually make their way across the pond to the US.
How the UK Government is Involved in P2P Lending
Unlike in the US where we have a massively distributed banking system with over 7,000 community banks, in the UK the banking system is highly centralized with approximately 90% of all lending completed by only five big banks. In both the US and the UK, the big banks have pulled back on lending to consumers and small businesses. This tightening has been greatly magnified in the UK due to the lack of alternatives. UK consumers and small businesses have struggled with virtually no access to capital.
In their first try, the UK government tried to accelerate lending by creating a program called Funding for Lending where the government provided low cost capital to the five big banks to encourage them to lend to small businesses. This initiative has failed miserably. As a result, that low cost government money has ended up building up bank balance sheets rather than trickling down to consumers and small businesses.
The UK government’s second try has worked much better so far. In late 2012 the Department of Business Innovation & Skills (BIS) created the Business Finance Partnership initiative. This initiative has dedicated £100m to alternative lending platforms to help fund small businesses and consumers. Two leading p2p lenders were the recipients of a good chunk of this money: Funding Circle received £20m and Zopa received £9m. As I mentioned yesterday this £20 million is being indexed across all of Funding Circle’s new small business loans with a 20% allocation to each deal. As a result of its early success, BIS has announced a new £300m initiative to expand this lending program. The initiative has accomplished two objectives: 1) it is providing credit worthy consumers and small businesses with much needed access to capital, and 2) it is providing credibility and awareness to alternative lenders in the UK.
Bring on the Regulation
Back in 2011 the three leading UK p2p platforms, Zopa, RateSetter, and Funding Circle, decided to band together to create a self-regulating body called the P2P Finance Association, which has since been joined by additional UK p2p platforms. This association proactively approached the UK government and asked to be regulated as a separate entity. The UK government has agreed and is in the process of developing a framework for regulation, a major section of which was released by the FCA today, and is expected to be implemented in April 2014.
The components of the regulation are broken into three categories: business practices, investor protection, and consumer regulation. In the first category, business practices, the regulation focuses on how p2p platforms should deal with clients and how to maintain proper capital requirements. In the second category, investor protection, the regulation focuses on how the platforms and their websites communicate investor information, standardization and communication of returns, and how to properly outline the risks associated with p2p investing. Finally, in the third category, consumer regulation, the regulation focuses on how p2p consumer regulation coexists with other forms of UK consumer lending regulation.
What the US can Learn from UK Regulation
Regulation for the US p2p market is divided between the investor side and the borrower side. Since 2008 the SEC has provided oversight on the investor side and Lending Club and Prosper have spent an enormous amount of time, energy, and capital to build solid SEC compliance.
Regulation on the borrower/platform side is still evolving and there is a lack of clarity on which regulator has final oversight. Bank regulators at the state level often oversee platform regulatory compliance, but those same platforms often partner with national banking entities, like WebBank, and therefore also receive oversight by the FDIC or the Federal Reserve. In addition, the CFPB has begun providing regulatory oversight in the student loan sector and, as reported by eBay earlier this week, the CFPB is taking an increased interest in the online consumer lending segment. And if you have been following along for a while, you may remember the GAO report released in the summer of 2011 that also talked about the CFPB as a possible overseer of this industry.
In my conversations with US regulators, I know that members of the Treasury, the Fed, and even President Obama’s economic council are closely watching these developments in the UK as they search for ways to help consumers and small businesses access capital here in the US. After my initial review of these regulations, it is apparent that US p2p lending platforms should read this consultation paper cover to cover and try to implement many of the policies set forth.
In particular, this paper proposes rules in the following key areas:
- Minimum requirements that firms must meet in order to ensure their ongoing viability
- Bankruptcy remote structures that ensure that existing loans can continue to be managed in the event of platform failure
- Rules on holding client money to minimize the risk of loss due to fraud, misuse, poor record-keeping, and to provide for the return of client money in the event of a firm failure
- Rules on resolutions and disputes
- Reporting requirements for firms to send information to the FCA in relation to their financial position, client money holdings, complaints and loans that they have arranged
- Rules on investor net worth to participate on these platforms
The FCA regulation has been welcomed by the UK p2p lending community. It is encouraging to see best practices take shape through this regulation. It would be helpful if a similar self-regulating body emerges in the US to push forward similar regulations here.